I am reposting this DD with some critical changes – the free float for ESSC is in fact 341,131 shares, which is the lowest free float of any post redemption SPAC so far. You can check this by reading pages 6-7 of the DEF14A filed on 15 Nov 21 for confirmation.
Link: https://sec.report/Document/0001213900-21-058879/
“Meteora and Glazer agreed not to sell, transfer or seek redemption of an aggregate of 974,658 public shares of East Stone and to vote such shares in favor of the Extension and the Business Combination.”
SUMMARY UP FRONT:
ESSC is an optionable SPAC with perfect pre-conditions set for a gamma squeeze. The tradeable float has been reduced to 341,131 shares due to redemptions and a forward share purchase agreement. The reason this is an extraordinary asymmetric trade compared to other SPAC gamma squeezes? Not only is the tradeable float the lowest seen so far (roughly 1/5 of IRNT), but the NAV floor protection is still in place.
INTRO:
Over the last few months people have been throwing money at incredibly risky SPAC ‘squeezes’ post-merger vote, when NAV protection has already gone. Some of them have worked and shot up by 50%, 100%, even 400%, but the vast majority come crashing back down e.g. TMC, OWLT, IRNT; and some just dump before they ‘squeeze’ – e.g. ML. With ESSC, however, you are protected by the NAV floor.
BACKGROUND:
ESSC is a SPAC with a definitive agreement (DA) to merge with JHD Holdings Limited. The JHD Group’s merchant enablement platform, which includes a digital e-commerce platform, provides a supply chain and the service infrastructure for fast-moving consumer goods to meet the daily needs of potentially millions of underserved consumers in the lower-tier markets of China and value-added services to financial institutions to potentially service millions of consumers underserved by financial institutions. JHD Group started its business in China in June 2016 and now services 95,000 independent merchant stores as of June 30, 2023.
If you’ve read the above, and think it sounds like a ropey deal – you are right. It is the epitome of a bad SPAC deal – the sponsors are up to grab north of $30m if the business combination is closed, and the JHD shareholders are able to cash out a fat cheque at a massively inflated valuation.
SITUATION:
However, despite having filed four revisions to its preliminary filing post-DA, it could not consummate the business agreement in time, and required an extension vote. This passed and the date was extended until the 24 Feb 2023. In this time they will call a merger meeting where you will again be able to redeem shares for NAV, or they will fail to consummate the business combination and the SPAC trust will be liquidated and shares redeemed at NAV – this is why there’s still a floor at $10.26.
As the extension took the SPAC past its original termination date and 2 x free extensions set in the IPO prospectus, the extension required a special meeting to vote and investors were able to redeem their shares. And redeem they did.
As per the most recent 8K filing, 10,534,895 shares were redeemed – 76.3% of the redeemable float (13,800,000 ordinary shares held by ESSC public shareholders. The remaining ordinary shares are held by the founders and underwriters, which are non-redeemable and are locked-up until post-merge).
After redemptions, that leaves a maximum of 3,265,105 public ordinary shares.
However, the part that makes this extraordinary is that prior to the extension vote, ESSC entered into a forward share purchase agreement with 4 arbitrage funds who likely were holding commons bought at sub-NAV to redeem for a small profit.
The agreement means that they are entitled to sell their common shares back to ESSC for $10.41 per share (if held for a period of time – 3 months – after the closing of the business combination), or sell on the open market commencing the day after the Business Combination Closing Date at a market price of at least $10.26 (and receive a $0.05 bonus if it’s within the first month post-combination, as part of an early sale premium so that ESSC can release the funds held in the escrow account). They have agreed not to sell, transfer or seek redemption for these shares and agreed to vote these shares in favour of the extension (which they did) and the merger vote. They will also receive 399,996 founder shares as part of the deal (these transferred shares are still subject to the same lock-up restrictions as the founder shares). The backstop investors are required to be net long, but this doesn’t stop them from boxing their founder shares to secure their profit.
Exact wording confirming the lock-up:
‘’ Meteora and Glazer agreed not to sell, transfer or seek redemption of an aggregate of 974,658 public shares of East Stone and to vote such shares in favor of the Extension and the Business Combination.’’
’’The Company has also entered into share purchase agreements with identical terms to the Glazer Purchase Agreement with Sea Otter (covering 974,658 shares) and with Mint Tower (covering 974,658 shares).’’
This is ESSC’s reasoning behind the backstop agreement:
‘’Certain of the Backstop Investors who held shares prior to signing the Backstop Agreements may have otherwise exercised their Redemption rights in connection with the Special Meeting or the Business Combination Special Meeting in the absence of such Backstop Agreements. If such shares were redeemed, the Company would be required to pay cash for such redeemed public shares from the Trust Account, in which case, such cash would not be available to the post-combination company. Although the amounts that would be paid to each of the Backstop Investors pursuant to the Backstop Agreements, if any of them exercise their option to sell the shares to the post-combination company in the future, are higher than the redemption price paid upon the exercise of the Redemption rights, the amounts being paid to each of the Backstop Investors reflect the risk that they are each bearing by agreeing not to redeem their shares in conjunction with the Extension and the Business Combination and to instead hold such shares for a longer period of time, allowing such shares that they each hold to potentially become a part of the public float of the post-combination company for a period of time following the Business Combination, and therefore, is higher than the estimated per share redemption price of $10.26. Furthermore, any other holder of public shares which chooses not to redeem such public shares in connection with the Extension or the closing of the Business Combination does not have any protection pertaining to the value of such shares if the post-combination company’s stock price drops below $10.26 per share, as such other holder would not have entered into any Backstop Agreement, which would obligate the Company to pay the holder a premium of up to $0.15 per share, and would obligate the Sponsor to transfer to the holder a certain number of founder shares, as consideration for the holder agreeing to hold its shares for a period of time following the closing of the Business Combination.’’
What do the hedge funds get out of this? A risk free profitable trade and a load of free shares. What does ESSC get out of this? 3m shares that aren’t redeemed and vote in favour of the business combination i.e. the merger vote is more likely to go through (and the founders can get their free shares, minus the ones they’re giving away in this agreement).
This leaves us with the following situation:
– 3,265,105 ordinary shares held by ESSC public shareholders (13,800,000 ordinary shares held by ESSC public shareholders – 10,534,895 shares redeemed).
– Of these 3,265,105 ordinary shares held by ESSC public shareholders, 2,923,974 are locked-up until the day AFTER the business combination closing date, as per the conditions stipulated in the backstop agreements.
– This leaves only 341,131 ordinary shares as the free float.
– Short interest is reported at 97,680 which would account for 29% of the free float.
– ESSC is optionable and with the massive reduction in the float, is open to a gamma squeeze.
-The backstop investors are able to box their founder shares (399,996 shares).
Daily volume on ESSC is minimal (65 day average = 64K).
The OI on the option chain is building up. Dec premiums are still relatively cheap and it will only take a small amount to start the gamma ramp – I have already bought 1000 Dec 12.5C. There may be some resistance against the boxing of the founder shares – to the tune of 399,996 shares – although the backstop investors consist of 4 different funds, so this is speculation – it could be less.
STRATEGY:
Buy commons close to NAV ($10.26). It is low risk. You can redeem or sell before the NAV floor is removed – be careful of share settlement times. If the deal falls through or is not completed by the 24 Feb 2023, the SPAC will be liquidated and public shareholders compensated at NAV. The further you buy away from NAV, the more risk you take. E.g. if you buy at $10.4, you are risking c.1%. If you buy at $11.4, you are risking c.%10 and so on.
There are other securities available to leverage: Warrants (2:1 @ $11.50), Rights (10:1), and options. But none of these have had a reduction in their float as they are not redeemable. They also don’t have a NAV floor and you could lose 100% of your investment i.e. if the business combination doesn’t occur, then the warrants, rights and options will all be worth 0.
This squeeze can only happen before the business combination. Post combination, there are convertible notes and Rights which will dilute the float significantly, and the backstop investors will be able to sell. Make sure you sell before the NAV floor is removed and the float is diluted.
If you buy common shares close to NAV, you can take on a predetermined amount of risk by buying a set number of call options. This is what I have done.
DISCLOSURE:
I am long 30,000 shares @ $10.4 average, and 1000 Dec 12.5c at $0.2 – total risk = 7.2% of position.
REDDIT DISCLAIMER: I am not a financial advisor, this is not financial advice.
LINKS:
ESSC investor presentation:
https://www.sec.gov/Archives/edgar/data/1760683/000121390021010227/ea135945ex99-2_eaststone.htm
ESSC SEC filings:
https://sec.report/Ticker/essc
This article was written by u/Puzzleheaded-Ad8266
